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Thousands of homeowners with adjustable-rate mortgages are about to face the pressure of higher monthly payments.

Thousands of homeowners with adjustable-rate mortgages are about to face the pressure of higher monthly payments.

Jordan Vonderhaar/Bloomberg/Getty Images

Single-family homes are seen in a residential neighborhood in San Marcos, Texas, U.S., Tuesday, March 12, 2024. As mortgage rates continue to rise, adding fuel to one of the most expensive housing markets in decades, adjustable-rate mortgages have gained traction.



CNN

Last year, when Jennifer Hernandez received notice that her mortgage payments on her Houston home would rise by about $2,000 a month, she was stunned.

Hernandez refinanced her home loan in 2016 using adjustable rate mortgagewhich has a low introductory rate for a fixed initial period.

Unlike the more common fixed-rate mortgages, variable-rate mortgages can provide temporary relief for homebuyers who want to avoid paying higher mortgage rates — however, they also come with risks. After a fixed application period — typically five, seven, or 10 years — the rate on a variable-rate mortgage adjusts periodically based on current market conditions.

That means many adjustable-rate mortgage holders like Hernandez are in for an unpleasant shock: their monthly mortgage payments will rise dramatically. And for thousands of Americans like Hernandez who got their adjustable-rate mortgages five years ago, before interest rates soared to four-decade highs, that shock is coming this year.

Mortgage rates remain high.Adding fuel to one of the most unaffordable housing markets in decades, adjustable-rate mortgages have gained traction despite their drawbacks.

According to data from Intercontinental Exchange, a global technology and data provider, 1.7 million homeowners have purchased homes with adjustable-rate mortgages since 2019. Many buyers who purchased five-year adjustable-rate mortgages — one of the most popular offerings — will see significantly higher monthly payments this year.

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The fixed-term of these variable-rate loans has already been reset for 328,000 homeowners — and another 102,000 loans will be reset over the next 12 months, according to ICE.

ARM loans gained notoriety after the subprime mortgage crisis of 2007 and 2008, after many homebuyers could no longer afford their monthly home payments when rates reset.

While the rate of homebuyers choosing ARM loans has never risen to pre-2008 levels, the share of homebuyers using ARM loans has doubled over the past four years, according to the Mortgage Bankers Association.

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The adjustable rate system may make sense for homebuyers who are comfortable with the risk of higher interest rates or those who plan to move or refinance before the fixed rate expires, Lorian Jones, a loan counselor in Southern California, told CNN.

But when choosing an ARM, it’s important to keep a close eye on the details, otherwise things can get tricky quickly.

Hernandez, a loan officer, had misremembered the terms of her $1.1 million loan: Instead of a 10/1 variable interest rate, which has a fixed rate for the first 10 years and resets every year after that, Hernandez had taken out a loan with a 7/1 interest rate.

“I was surprised,” she said. “Life gets in the way of me, and it keeps me busy. I’ve been busy with kids and work for the past seven years.”

Last October, Hernandez’s mortgage rate rose 2 percentage points to 5.125%, the maximum allowed in the first adjustment year, according to the terms of her loan.

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Most ARMs come with an interest rate cap to keep costs from getting out of hand. Hernandez said her ARM’s cap is 8.125%, five percentage points above the initial fixed interest rate.

For Hernandez, it didn’t make sense to refinance the loan while the 30-year fixed mortgage rate was still higher than the new adjusted interest rate. But she suspects her monthly payments will rise in October.

“I made it happen, but now I have to figure out how to make it happen again in October,” she said. “It’s stressful having to worry about that.”

Andrew Marquis, a loan officer in Lexington, Massachusetts, said he’s seen a big increase in applications for adjustable-rate mortgages recently. Homebuyers increasingly believe the Federal Reserve will cut interest rates in the next few years, giving them time to refinance their loans before the expiration of the adjustable-rate mortgage, he said. The Fed doesn’t directly set mortgage rates, but its actions influence them. This year, The Federal Reserve indicated It may cut the benchmark interest rate once.

“I would say about 40 percent of the loans we do are variable interest,” Marquez said, referring to loan amounts exceeding $766,000.

Marquez said taking out an ARM loan could be beneficial for those with a higher appetite for risk.

“If people can save half a percent on a seven-year interest rate loan versus a 30-year fixed rate loan, they are saving hundreds of dollars a month,” he said.

Interest rates can be unpredictable. Hernandez says she saved money in the first seven years of her loan, but if she had the chance again, she probably wouldn’t have chosen the adjustable-rate mortgage in 2016.

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“This increase in payments has not been good, and I pray that the rates will come down a little bit when my adjustment comes in October,” she said.